NEW YORK (TheStreet) -- The repercussions of 2008 financial crisis and the outcome of consequent financial reforms have been an ongoing topic of debate.
While the Obama administration created regulations to ensure the resilience of the banking system, many believe that the "too big to fail" problem continues to exist. New York Times columnist Andrew Ross Sorkin popularized the expression in the title of his 2009 best seller on the 2008 financial crash. Sorkin articulated the then-belief among many respected observers of the economy that certain financial institutions could not fail largely because of their size.
Regulation is likely to be a major economic theme in the 2016 Presidential election.
This summer, four U.S. senators working across party lines, including John McCain (R-Ariz.) and Elizabeth Warren (D-Mass.), who has been mentioned as a potential Presidential candidate introduced a bill that would return some of the Depression-era Glass Steagall's closer scrutiny of financial services companies.
The supporters of such regulation believe that if Glass-Steagall had remained, the 2008 damage to the banking industry and the economy would have been more limited. Opponents of such regulation say that the financial crisis had little to do with a partial repeal of the bill that took place during the administration of Bill Clinton.
About Glass-Steagall Act
The Wall Street Crash in 1929 led one in every five banks to fail. The Banking Act of 1933 (also know as Glass-Steagall) was formed to lift the economy after the crippling 1929 stock market crash and Great Depression. The Act gave additional powers to the President to act during the banking crisis. It also created restrictions, including prohibiting integration of a commercial bank with an investment or insurance company.
From the 1960s, the Fed started to loosen Glass Steagall, and in 1987, banks were allowed to underwrite and deal in securities. These included commercial paper, municipal revenue bonds and mortgage-backed securities. With intense lobbying and financial modernization, Glass-Steagall was soon considered obsolete, and legislation was signed to repeal the Act.
Repeal of 'Glass-Steagall Act'in 1999
In 1999, under President Clinton, a part of the Glass- Steagall Act was repealed in what was known as the Gramm-Leach-Bliley Act (GLBA). Supporters of the repeal believed that the Act had worked for its time and with increasing economic prosperity, it was time to remove certain restrictions on banks. According to the Wall Street Journal, President Clinton agreed that the Act was "no longer appropriate to the economy in which we live. It worked pretty well for the industrial economy . . .. But the world is very different."
The Problem of 'Too Big To Fail'
During the 2008 crisis, a number of commercial banks were so huge and complex that if allowed to fail, they could have decimated the economy. Due to such huge risk, the government bailed them out, eventually saving big banks from defaulting on their large debt. However, since then, big banks have functioned on an even larger scale. It has been argued that saving them birthed bigger problems, among them, the issue of moral hazard.
Reforms Due to 2008 Financial Crisis
The Dodd-Frank Wall Street Reform and Consumer Protection Act, simply known as Dodd-Frank, was passed as a law by the Obama administration in 2010 so that events similar to 2008 did not repeat. It aimed to address the "too big to fail problem" by separating risky activities under section 619 known as the "Volcker Rule." Passed by the Senate, the rule restricted banking entities from betting in speculative activities from their own accounts through "proprietary trading."
Volcker Rule vs. Glass Steagall
The Volcker Rule, under the Dodd-Frank Law has often been compared to the Glass-Steagall Act of 1933, which was designed to separate investment banking from commercial banking during the times of the Great Depression in 1930s. According to New York Times, Volcker rule was called "Glass-Steagall in spirit."Both the Volcker rule and Glass-Steagall were reformatory measures for crises of 2008 and 1929 respectively, but Volcker Rule seems far more complicated than a much simpler Glass-Steagall.
The 21st Century Glass Steagall Act
This summer, Sens. McCain, Warren, Maria Cantwell (D-Wash.), Angus King (R-Maine) worked across party lines to introduce bill that would bring back the Glass Steagall Act. In explaining the bill, Warren said that "if banks want to engage in high-risk trading, they can go for it, but they can't get access to insured deposits and put the taxpayers on the hook for that reason."
This group found support from colleagues. "It's no secret that Too Big to Fail is still around," Sen. David Vitter (R-La.) said in a statement. "If another financial crisis happened tomorrow -- and that's still a real risk -- nobody doubts that megabanks would be calling on the federal government to bail them out again."
Good Idea or Bad?
Former President Clinton defended the repeal of the Act and said that it had nothing to do with the crisis. Defending the repeal, in an interview with Inc. magazine, he said that "unified banks" tend to fail less than," the commercial banks that overloaded on subprime mortgages, or the investment banks, like Bear Stearns, Lehman Brothers, and others."
Former Rep. Barney Frank, for whom Dodd-Frank was partly named, thinks that reinstating the Glass-Steagall Act is wrong, but he supported Hillary Clinton regarding the need for more financial regulation.
Many economists agree that the Glass-Steagall Act could not have prevented the financial collapse in 2008, since the real offenders of the financial crisis were not the banks, but non-banks like Bear Stearns and Lehman Brothers, which had 'bank-like' qualities.
However, Robert Reich, Chancellor's Professor of Public Policy at the University of California at Berkeley, has argued that the non-banks received funding from big banks through such means as mortgages and letters of credit. Reich maintains that if Glass Steagall had been in effect, then the big banks could not have given non-banks funding. He says that might have prevented the crash.
To be sure, much of the financial crisis was due to lapses in the entire financial system. That Glass-Steagall worked in 1930s doesn't mean that it would have worked in 2015. Yet it might have at least limited the damage.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.